The Chairman of the European Securities and Markets Authority (ESMA), Steven Maijoor, has heightened concerns for liquidity risk within the asset management sector. He expressed his views at a recent speaking engagement by noting that, based on the shutting down of the Woodford fund in Great Britain, he believes that fund managers may be “flouting liquidity rules”, designed to protect investors in the event of massive withdrawals.
Based on his concerns, he says that his agency will target this group, specifically known as an EU-regulated fund referred to as an “Undertaking for Collective Investment in Transferable Securities” or “UCITS”. Andrew Bailey, his counterpart at the FCA, has already deemed the redemption rules governing UCITS as “flawed”, but Maijoor prefers to take audit measures as a first step and method for gaining facts. ESMA will direct national regulators to apply a common approach in their various liquidity checks.
Reuters reported that Maijoor made his remarks at a conference sponsored by the European funds industry body (EFAMA), since a number of incidents have “called the UCITS ‘label’ into question”:
For this reason, in order to foster convergence and promote consistent supervision with regard to liquidity risks, ESMA will facilitate a common supervisory action on liquidity management by UCITS.
One event in question was the recent shuttering of the Woodford fund. Reuters reported in October that:
Neil Woodford has been ousted from his flagship LF Woodford Equity Income Fund which will be shut down to pay back investors whose money has been trapped since June. Trading in the now 3 billion pound ($3.8 billion) fund managed by Woodford, one of Britain’s most high-profile money managers, was suspended four months ago after poor performance led to an increase in demand from clients to take their money back.
The Woodford fund permitted investors to make withdrawals on a daily basis, rather than having to wait for specific period endings, such as at the end of a month or quarter. Such restrictions generally allow the fund manager time to liquidate holdings that are in very shallowly traded markets. Investors are typically unaware of redemption issues when investing in a fund, but in this case, the current estimate is that they could lose in excess of 1 billion pounds ($1.28 billion).
The run on the fund occurred when poor results were published, and terrified investors rushed to the redemption window, asking for immediate withdrawals. Fund managers are supposed to plan ahead for such occasions by maintaining reserves in cash or cash equivalent investments. Secondly, an adequate portion of the portfolio is often placed in markets that are easy to liquidate holdings at a moment’s notice. It is difficult to pattern specific rules that dictate how judgment is applied, which is the core of the issue.
In this era of near-zero and negative interest rates, the demand for high returns often pressures a fund manager to go higher up on the risk pyramid to satisfy the goals of an investment fund. Higher risk typically means less liquidity, a lesson that many asset managers learned rather harshly during the last financial crisis a decade back. It was found that Woodword had gone well beyond the “EU cap on holdings of illiquid or hard-to-sell assets”.
Woodword had argued that his questionable assets resided on an exchange, but the exchange was a lightly traded one in Guernsey. As Maijoor concluded:
A listing on an eligible market does not automatically mean that all specific securities of such market are actually liquid.
Liquidity checks are expected to begin in 2020.
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ESMA Chairman targets asset managers for adequacy of liquidity concerns was first posted on November 26, 2019 at 11:04 am.